Photo AI
Explain, with the aid of a diagram, the Circular Flow of Income in an open economy - Leaving Cert Economics - Question b - 2017
Question b
Explain, with the aid of a diagram, the Circular Flow of Income in an open economy. Outline how each of the following Budget 2017 policies should affect the circula... show full transcript
Worked Solution & Example Answer:Explain, with the aid of a diagram, the Circular Flow of Income in an open economy - Leaving Cert Economics - Question b - 2017
Step 1
Explain, with the aid of a diagram, the Circular Flow of Income in an open economy.
Answer
The Circular Flow of Income illustrates the movement of money, goods, and services in an economy. In an open economy, the diagram includes interactions between households, firms, government, financial institutions, and foreign markets.
-
Households supply the factors of production (land, labor, capital, and entrepreneurship) to firms, in exchange for income, which includes wages, rents, profits, and interest.
-
Firms produce goods and services, generating revenue and subsequently paying households for the factors of production they provide. This income flows back to households, which use it to purchase goods and services.
-
Not all income is spent; some is saved in financial institutions. Households deposit money in these institutions, and in return, they may receive interest.
-
The government plays a crucial role through taxation and expenditures: it collects taxes from households and firms and spends on public goods and services. Government expenditure influences the overall economy by injecting funds.
-
Finally, the circular flow includes interactions with foreign markets, where households and firms import goods or services, and in return, they export, creating a two-way flow of money and goods.
The Circular Flow of Income diagram thus visually represents these economic exchanges, showing the continuous loop of spending and income generation.
Step 2
Outline how each of the following Budget 2017 policies should affect the circular flow of income.
Answer
Capital spending on road and rail projects of €4.5 billion.
This policy injects a significant amount of money into the economy. The increased capital spending is likely to lead to:
- Increased aggregate demand, as firms are contracted to provide goods and services for these projects.
- Job creation, boosting household incomes as workers are employed in the construction and associated sectors.
- Multiplier effect, stimulating further spending through the economic activity generated.
A reduction in the amount of the universal social charge (USC) that workers must pay.
This policy results in:
- Higher disposable income for households, allowing them to spend more on goods and services.
- An increase in consumer spending, which drives demand for goods and services, leading firms to potentially increase production and employment.
- Overall, this change should enhance the circular flow of income as the additional income will circulate back into the economy.